Thursday, February 26, 2009

When It Comes to Solving Our Long-Term Budget Deficits, Tax Policy Changes Don’t Matter

Are you sick of all the tiresome yammering in Congress and on the cable and radio talk shows about raising or lowering taxes to pay for the new bailout and spending programs?

Congratulations. You are way ahead of the politicians and their consultants.

Changes in tax policy are very important for creating new businesses and jobs, especially in this time of economic crisis. Tax changes and incentives have profound effects on businesses making strategic decisions about expanding operations and creating new jobs for people; there is no doubt about that.

But when the debate turns to raising or lowering taxes to “balance the federal budget”, you can tune out all of the politicians and hot-tempered talk show hosts on both sides.

The truth of the matter is that changing tax rates up or down really does not matter very much when it comes to solving this huge budget mess we have gotten ourselves into.

Bill Clinton’s famous campaign slogan from 1992, “It is the economy, stupid!” can be amended to read: “It is the spending, stupid!” and applied precisely to our current and future budget dilemma.

There is simply no way we can raise tax rates high enough on anyone in this country to pay for all the services we want each year. There is no way we can cut tax rates far enough to generate the rapid growth in tax revenues on a supply-side basis to cover all of our current spending. The tax debate to solve our deficit and debt crises is a sideshow that can be set aside for now.

So just ignore all of the venom spit out from both sides on the tax front. It just doesn’t matter much when it comes to balancing the federal budget.

Understanding what is important in the federal budget and what is not

There are three things that have to done in Congress to lead us out of this budget dilemma and none of them have to do with tinkering with the tax code:

* Control the relentless perpetual growth in federal entitlement spending
* Confront a bloated health care system and
* Examine every line item in defense and discretionary spending which now accounts for less than 39% of total spending

When it comes to understanding the federal budget, one should heed the opening lines to Dante’s “Divine Comedy”: “Abandon hope, all ye who enter here!”

The federal budget is massive at over $3.5 trillion now (and counting), confusing and mind-numbing which is the way politicians like to keep it. The more confusing it is, the more the federal budget can be manipulated for political advantage by both sides. Partial truths abound, the public gets confused and critical national decisions get punted down the road.

We elect our representatives and senators and send them to Washington supposedly to cut through the confusion, make tough decisions, and tell us the truth about our country’s finances. For the past 40 years, and perhaps as long as there has been civil democratic government from Greece to Rome to us in the 21st century, the public has been hoodwinked into believing that all we have to do is raise taxes “on the rich” or “cut taxes for everyone” and our problems will just fade away.

They won’t…and we have empirical proof from the past 40 years that shows raising or lowering tax rates has not solved our budget problems in total.

No matter how much Congress has tinkered with the tax code in attempts to spur massive new amounts of tax revenue to flow to Washington to cover our budget deficits, the result has been the same: federal spending has almost always exceeded incoming tax revenue.

Politicians--on both sides of the aisle--wave the bloody shirt of “taxes” to rally their voters to the polls. What they are really doing is squirting out ink like an octopus to confuse the public. It is fun and easy for a politician to promise tax cuts to everyone or to “sock it to the rich” by trying to raise taxes on them. Anyone who runs for office can do both well without any training at all.

But the end result is always the same…the amount of money sent to Washington has been a virtual flat line relative to the size of our economy defined as the gross domestic product or GDP since 1970.

It is far more difficult to get elected by telling the country to face the truth and then announce specific reductions in federal programs they would support.

The facts, plain and simple.

Since 1970, total revenue to the federal government-- including income, FICA, excise, corporate and capital gains taxes-- has averaged 18.3% of GDP per year, while annual total federal spending has averaged 20.6% of GDP.

This has produced an average of a 2.3% budget deficit per year relative to GDP for 40 years. The budget deficit for 2008 alone was $460 billion. The federal deficit is expected to be $1.6 trillion for FY2009 or 8.6% of GDP and possibly higher in 2010.

To put this into perspective, the entire federal budget in 1987 was slightly over $1 trillion. We will overspend incoming tax revenues this year by more than the entire federal budget in 1987! The excess is simply breathtaking.

Senator Everett Dirksen (IL) purportedly once said: “A billion here and a billion there and pretty soon you are talking real money!” What would he say today?: “A trillion here, a trillion there…”? Our national debt is nearly $11 trillion and exploding rapidly. It was “only” a mere $5.6 trillion in 2000.

For 40 years, despite all of the time, energy and millions of campaign dollars we have expended on the tax debate, we have failed to pay for all of the programs we want to have. The only exceptions were the three brief years from 1998-2000, when budget surpluses resulted from rapid growth in the internet boom economy and a spending reduction compromise achieved by President Bill Clinton through his chief of staff at the time, Erskine Bowles, and the Republican-controlled Congress in 1997.

For those all-too-brief three years, the American people can honestly say that Washington did a great job as financial stewards of the public trust and treasury.

The other 37 years dating back to 1970 were political/fiscal failures. The reason? There has not been a concentrated, sustained attempt, supported by a majority of American voters, to reform federal programs and restrain overall spending from Washington. Ronald Reagan once said, ‘The nearest thing to eternal life we will ever see on this earth is a government program’. We have failed to control spending that would allow even robust tax revenue growth to cover all of the spending we say we want.

As a society, we have casually concluded that we would rather spend it all now and ask our kids and grandkids to pay for it all during their lifetimes, not ours.

Dietrich Bonhoeffer, the great German theologian who sacrificed his life in a plot to assassinate Adolf Hitler, said, “The ultimate test of a moral society is the type of world it leaves its children.” In terms of fiscal and financial responsibility, where does that leave us as once-proud American citizens who want to leave a better future for our children and grandchildren? What has happened to us as a nation?

Supply-side tax cutting advocates say that tax revenue roughly doubled in the decade from 1980 to 1990.

Well, they did. But so did tax revenues from 1970-1980, from 1990-2000 and probably will do so again, believe it or not, between 2000 and 2010. Tax revenues are more a function of a healthy, vibrant economy that encourages people to take risks, hire workers and pay taxes on wages and capital gains than changes in the tax code.

One troubling and irrefutable “fact” about tax revenue from 1984 under Presidents Reagan, Bush 41, Clinton, and Bush 43 to the present under President Obama is that the total amount of tax revenue sent to Washington has been swollen by the 1983 Social Security compromise pushed by Senators Bob Dole and Daniel Patrick Moynihan and signed into law by President Reagan. The bill accelerated previously enacted FICA taxes and significantly increased the individual payroll tax rate to “save Social Security” which was insolvent at the time.

The payroll tax is effectively a “flat-rate tax” that affects the rich and the poor, the just and unjust alike. So much for the argument against flat-rate taxes….we already have had one in place since 1935.

The so-called “Social Security surplus” generated by the 1983 bill is now over $185 billion per year.

Without this extra tax revenue surplus, our annual deficit and national debt would be much greater today.

Another “inconvenient truth” is that, despite repeated efforts to raise taxes “on the rich” to pay for our collective national bills, raising tax rates on the rich has not solved our deficit problem. Why? There are not enough rich people to pay for the costs that benefit us all, from defense to homeland security to education and to Medicare.

In spite of this fact, the top 1% of the wealthiest Americans has been paying a progressively higher percentage of total income tax collected by the IRS each year since 1980. They paid over 40% of all income tax revenue received by Washington last year.

This may be hard to believe but close to half of all American taxpayers pay zero in income taxes annually, a percentage that has been growing as well over time.

That leaves the rest of us, roughly 90 million or so tax filers, to pay the rest of the income tax collected per year, now estimated to be approximately $700 billion this year.

Do we really want a democracy where “the rich” act like Santa Claus for the rest of us? Do we really want the top 1% of the wealthiest Americans to pay all of the income taxes one day? Who will have the final say in national matters then?

Overdependence on the taxpaying ability of the wealthiest of our citizens is not a viable balance to sustain a democracy into the foreseeable future. Take a look at the dramatically lower tax receipts as a whole we will get from them during this financial meltdown.

One radical pipedream might be to double the tax rates on the top 1% of the wealthiest Americans…if we collected $465 billion in income taxes from them in 2007, why not try to get $900 billion out of them next year and the next?. This will never work simply because rich people can afford to pay for the best tax and accounting advice and limit their tax exposure through legitimate investment planning.

Another possible way to balance our budget would be to raise approximately $5,000 more in income taxes from about 100 million taxpayers. This would net $500 billion more in tax revenue sent to Washington annually. But I have not seen anyone volunteering to send $5000 more to Washington each year and no sane politician would propose it either.

Don’t be Deceived

The next time you see a politician moving their lips promising to raise or cut taxes in an effort to “balance the federal budget for our children and grandchildren”, just remember: it is pure, unadulterated balderdash.

Politicians know it is impossible to balance the budget and pay off our national debt with tax policy changes alone.

Solving the federal expenditure dilemma is going to require a Herculean effort on the part of the American people first to learn what can be done and then vote for politicians who will bring back fiscal sanity to the nation’s capital.

Over the next several months, and perhaps years, I will be presenting common-sense budget options that can reduce federal spending by over $1 trillion in the near future and reduce the claim on future budgets by up to 10% of GDP.

If you agree or disagree with them, contact your congressional representative or Senator. They need to hear what you think before they will act for the good of our country.

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